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Consolidation of Control - Where to Draw the Line?

27 February 2009

Mayer Brown JSM Legal Update

Summary

Recently, the Securities and Futures Commission released two Takeovers Panel decisions made in 2008. The first one (released on 19 January 2009) relates to whether a waiver of a mandatory takeover offer obligation should be granted to Swire Pacific Limited ("Swire") for acquiring additional voting rights in Hong Kong Aircraft Engineering Company Limited ("HAECO") from Cathay Pacific Airways Limited ("CX"). The second one (released on 24 February 2009) relates to whether a mandatory offer obligation would arise as a result of members of the Fung family ("Fung Family") and China Life Insurance Company Limited ("China Life") acquiring 5% and 10% voting rights respectively in Wing Hang Bank, Limited ("Wing Hang Bank") from BNY International Financing Corporation ("BNY").

In each case, the concert group already has majority interest in the target company, and the leader of the group would remain unchanged. Nonetheless, a mandatory offer obligation was considered applicable and no waiver was granted. The critical issues that the Panel took into consideration in delivering its rulings were, among other things, whether the leader has acquired additional rights as would enable it to consolidate control in the target company, whether there will be a significant change to the balance of the shareholding, and the price proposed to be paid for the voting rights.

Full Update

What happened in the Swire case?

Swire has for many years been the largest shareholder of CX, and as such has also been the single largest member of a concert group which together holds a majority interest in HAECO. The concert group comprises Swire itself, CX, Citic Pacific Limited ("Citic Pacific") and Air China Limited ("Air China"). At the time when the case was laid before the Panel, Swire was holding 33.52%, and together with other members of the concert group, more than 50% voting rights in HAECO:

What was proposed is that Swire would form a subsidiary with CX ("Newco"), with CX as the minority shareholder. Newco would buy from CX and Swire a total of 18.50% voting rights in HAECO at an indicative price of around HK$95 and no higher than a ceiling price of HK$106.56, being the 180 trading day volume weighted average price of the share in HAECO as at 26 November 2008. If the proposal were implemented, HAECO's shareholding structure will change to:

The Panel considered that Swire and Newco should be taken together and counted as one. As such, Swire would be taken to have increased its interest in HAECO by the same amount of shares that Newco would buy in HAECO, i.e. from 33.52% to 50.12% and crossing over the trigger level where Swire would be required to make a mandatory takeover offer for HAECO under rule 26.1 of the Takeovers Code.

Swire sought for a wavier of such obligation from the Executives who then referred the application to the Panel for a view. The Panel decided that no waiver should be granted.

What happened in the Wing Hang Bank case?

Wing Hang Bank was founded by the Fung Family. At the time the case was laid before the Panel for consideration, the Fung Family and BNY were holding 23.58% and 20.28% voting rights in Wing Hang Bank. BNY intended to reduce its shareholdings in Wing Hang Bank by disposing 5% and 10% to the Fung Family and China Life respectively. The parties also proposed to amend a shareholders agreement between the Fung Family and BNY by including China Life as a party to the agreement and adding certain additional rights to the Fung Family including:

a right to nominate one more director than China Life to the board of Wing Hang Bank;

restrict China Life and BNY from holding more than 25% of Wing Hang Bank unless the Fung Family disposes of 5% or more of its stake in Wing Hang Bank;

a right to require China Life and BNY to sell their stake to such third party to whom the Fung Family shall transfer its entire stake in Wing Hang Bank.

The parties sought a ruling from the Executives that no mandatory offer obligation would arise as a result of the proposal and the Executives referred the matter to the Panel for clarification. The Panel ruled that a new concert group in relation to the shareholdings of Wing Hang Bank will be formed and that the Fung Family would be required to make a mandatory takeover offer for Wing Hang Bank under rule 26.2 of the Code.

Issues for thoughts

Consolidation of control

In the Swire case, Swire would increase its interest in HAECO from 33.52% to 50.12% following the proposal, thereby also acquiring statutory control of HAECO. In other words, it would have absolute control of more than 50% voting rights in HAECO, without having to refer to other members of the concert group. Having statutory control also means that the provisions of rule 26.1 of the Takeovers Code would no longer apply, and Swire would be free to acquire further shares in HAECO without incurring mandatory takeover offer obligation.

In the Wing Hang Bank case, although the Fung Family may not have acquired statutory control over Wing Hang Bank, it would acquire additional rights in Wing Hang Bank by virtue of the proposed amendments to the shareholders agreement. The Panel considered that those new rights would allow the Fung Family to consolidate control over Wing Hang Bank.

Change in the balance of shareholding

In both cases, the Panel considered the changes that would arise in the balance of the shareholdings among members of the concert group are significant.

In the case of Swire, the Panel highlighted its concern in CX's reduction of its interest in HAECO from 27.45% to 10.84%, and in Swire enhancing its control to a statutory one where rule 26.1 of the Takeovers Code would no longer apply. In the case of Wing Hang Bank, the Panel took specific note that BNY would dispose of about 74% of its holdings, reducing its interest in Wing Hang Bank from 20.28% to 5.28% which the Panel considered as "clearly significant".

Price

It is a fundamental principle of the Takeovers Code that all shareholders should be treated even-handedly. If a purchaser acquires control by buying at a premium over the market price, it raises a greater concern that an offer at the same premium should also be extended to the rest of the shareholders.

In the Swire case, the price contemplated under the shares in HAECO is around HK$95 with the ceiling price of HK$106.56, representing a premium of 35.7% and 52.2% to the prevailing market price of the shares in HAECO. The Panel noted that the Takeovers Code provides no particular guidance on the size of premium that may be acceptable but considered the premium in the Swire case to be significant. Interestingly, the Panel also noted in the Swire decision that in almost all the waivers granted by the Executives under note 6 of rule 26 of the Takeovers Code in the past, no premium has been paid.

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